Market Microstructure in Emerging and Developed Markets

CHAPTER 23

Trading Costs and Execution Strategies in Emerging Markets

MARK HUMPHERY-JENNER

Assistant Professor, University of New South Wales

ELIZA WU

Associate Professor, University of Technology, Sydney

INTRODUCTION

Trading costs are an important consideration for all investors. Transaction costs can be a major impediment to trading in emerging markets and can help to explain why some foreign investors avoid emerging markets (Edison and Warnock 2004). Consistent with this view, firms also consider transaction costs when deciding where to list their stock and raise capital (Halling, Pagano, Randl, and Zechner 2008). Much evidence in the finance literature suggests that trading costs matter for financial activity. As such, the quality of a market can be approximated by the costs of trading, and much interest exists in market microstructure research on transactions costs and liquidity.

The most obvious trading cost is the possibility of relatively high fees. However, the more important trading costs come from illiquidity, attendant problems of price impact, and nonexecution risk. Short sale restrictions can also create added costs and limit hedging strategies designed to ameliorate nonexecution risk. Also, the transparency of broker identities (IDs) can impose extra costs in part, by deterring some traders, while creating new trading strategies arising from the information imparted by knowing who is placing a trade.

While economic benefits can result from diversifying internationally ...